Payroll Outsourcing

Produced with Accountancy Age and Sage

This document is also available as a pdf for download. 

Comforting signals are beginning to be picked up from economic commentators about the UK business climate. Business directors may be drawing breath and perhaps starting to feel that the worst is over.

However, economic recovery is never entirely predictable and 2010 may still be a hazardous time for trading. Business managers and directors understand all too well the need to maintain vigilance and know that they will do well to keep their operations under review if they are to emerge from this recession in good shape.

It is conservatively estimated that around 95% of businesses in the UK outsource at least one of their business processes and the trend towards outsourcing shows no sign of abating. The potential to cut costs and streamline operations using an outsourcing arrangement means it continues to be an attractive way of putting some financial certainty into the business plan.

Martyn Hart, chairman of the National Outsourcing Association, says that popularity of outsourcing is only likely to increase. “What we are seeing now is the growing maturity in users of outsourcing, while those that haven’t considered it before are also getting in on the act.”

In a survey of 270 medium and large businesses conducted by Accountancy Age, a resounding 94.5% of respondents said cutting costs and improving delivery across their administrative functions would be ‘essential’ or ‘important’ to them in 2010. Some 51.5% of the sample said it would be essential, as they wouldn’t maintain current margins without cuts or demonstrable improvements in efficiency, while 43% confirmed such measures were important, but not urgent.

The 2010 Accountancy Age survey into outsourcing payroll found respondents generally open to the idea of outsourcing. A majority, 61% said they were fairly open to the idea, given the right price and service levels. Some 19.7% said they were very open to the idea, but not actively revising their existing set ups. On the other hand, another 19.3% said they were satisfied that their in-­house provision met their needs and was cost effective

Hart argues that buyers and potential buyers of outsourcing services have increasing expectations. “As end ­users become more skilled at sourcing many are looking beyond simple overhead reduction towards business enhancement. We are already seeing an increase in the sophistication of outsourced processes and trends like multi-­sourcing continue to grow in popularity,” he says.

In­-house operations and their difficulties

Payroll is a common starting point when it comes to outsourcing business operations. Of the businesses polled, 63.2% had already outsourced their payroll operations, while 19.5% had also outsourced other areas of their HR management. Why? “The core reason is that a significant part of the cost of managing payroll can be spread across multiple companies,” says Alan Hopwood, business process outsourcing and shared services consultant at EquaTerra.

The business case for payroll outsourcing as opposed to other functions is also strong in terms of reputational risk. As Jimmy Desai, a partner at London law firm Blake Lapthorn and an outsourcing specialist, points out, the fact that it is a back-office function rather than a customer­-facing one makes payroll an area that people are comfortable handing over to a third party. “Businesses don’t necessarily set too much store by who does it,” he argues, “providing the outputs are the same or better, then they are happy. Businesses are more likely to be attracted by payroll outsourcing than something like a call centre that would put their reputation on the line.”

That is not to say that payroll is unimportant. In fact, for all businesses that have survived recent months perhaps by downsizing, or at least by depending on the goodwill and efforts of their staff, paying people correctly and on time is not something that should be taken lightly, argues Rebecca Clarke, an adviser at the Chartered Institute of Personnel and Development. “People would seem to think that payroll is one of the more straightforward areas in terms of the outsourcing proposition. That’s easy to say, but in fact it is a terribly emotive area. Get people’s pay wrong, pay them late ­in terms of the psychological contract it is crucial. People think their efforts are not being recognised.”

In the Accountancy Age survey, a failure to deliver payroll operations on time across the whole business scored highly as an operational risk at 31%, suggesting that its importance to organisations is properly recognised. Payroll’s complexity can also be an issue. Maintaining sufficient expertise in payroll legislation and system knowledge was cited as the greatest risk by 30.6%. In fact, running an in-­house payroll set up can highly onerous, as Alan Hopwood points out. Expertise, whether that is expertise in legal, HR, tax or systems matters, is concentrated in the hands of a small group of people. The system risk is also not inconsiderable, he argues. When asked about additional benefits they would most expect to gain from an outsourcing arrangement, 63.6% said access to legal and taxation expertise, 38% said access to IT assistance, ideas and upgrades and 33.5% said provision of additional management information, suggesting that respondents are mindful of those risks.

The time­-consuming nature of payroll management was also found to be an issue. Changes in headcount at 31.7% and payments to contract and/or temporary staff at 23.3% were noted as time­-consuming elements of payroll management.

The survey found a number of other pain points. When asked which aspects of running an in­-house payroll function were most costly, 35% cited staff; 17.1% said software and hardware and 16.3% said training, additional consultancy or other expert input. To those, Jimmy Desai adds premises and management costs. “If your payroll function is outsourced you may not need that extra floor in your building or to devote management time to that payroll team.”

It should be noted, however, that many were happy with the operation of in-­house systems. Of the two thirds of the respondents that had an in-­house system, the majority said it ran on time and without hold ups every month. Only two individuals out of the 166 who answered said they had frequent difficulties. What’s more 51% of the sample said they viewed payroll management as straightforward, with an automated system and level of internal expertise that met their needs.

In some cases, keeping systems in-­house will be an appropriate measure. Where a company has a well performing payroll, managers will see no reason to risk changes, says Hopwood. “Where the in-­house system is efficient and of a scale to be reasonably cost competitive, then the cost of transition can kill the business case for outsourcing,” he says. However, failing to keep this key provision under review is itself a risky strategy and in some cases the need for periodic investment may be ignored, he argues. Ideally, organisations need to make sure internal costs are well understood and evaluated.

Benefits of outsourced operations

In the Accountancy Age survey, the most important benefits of outsourcing payroll were perceived to be increased cost­-effectiveness at 42.4%; increased efficiency and timely delivery at 29.4% and the removal of non­core processes from the business at 28.2%. Cutting costs was seen as ‘important’ to 31% but 52.7% answered that they were ‘not pressing’. Clearly there is a balance to be struck between priorities such as cost, removing complexity and receiving a quality service.

“Payroll is a time­ consuming process, but also one that owes itself nicely to outsourcing,” says Martyn Hart. “Delivering payroll entails lots of regularly ­repeated actions and process ­driven activities, making it easily ‘packaged’ for outsourcing. The fact is that many of the big outsourcers that take on payroll, can now do it much more efficiently and effectively than an in-­house department. Though it isn’t a massive overhead it simply makes sense to get a specialist in who can easily process payroll at whatever scale is required. The key take­out here is less stress rather than lower costs,” says Martyn Hart.

The ability to hand over a fluctuating workload was considered desirable or very desirable to 72.7%, and this is an important benefit, argues Hart. “So many business tasks have an element of scalability where staff can be overly busy on one day and stuck for things to do on another. Outsourcing enables a company to insure itself against these kind of fluctuations, scaling up and back as is required.”

When asked whether past or existing outsourcing arrangements had helped to reduce headcount 135 out of 235 who answered, said yes, while 131 out of 230 said those arrangements had helped to eliminate repetitive tasks. But outsourcing can be of benefit not just in relation to cost­ reduction plans or as a way or pre-­empting the need to invest in new systems, Alan Hopwood points out. It can also provide a solution if key payroll staff are due to retire or as a means of coping with significant organisational changes, such as a merger or divestment.

One of the big selling points of outsourcing non­-core functions of all kinds from a strategic point of view is that it enables business managers ­whether in HR, IT or finance ­to concentrate their fire on core business activities.

Rebecca Clake says outsourcing repetitive, transaction ­heavy areas like payroll frees up HR departments ­or senior managers with responsibility for people management issues ­to look at their future needs. Focussing on recruitment and learning and development, for instance, enables businesses to look and plan ahead. “Giving the workforce the skills that enable them to do their jobs to the best of their ability is an area where you might be able to add value longer term.”

Outsourced payroll in practice

Given the financial turbulence facing most organisations, the HR outsourcing agenda remains one of the key priorities for HR directors, according to Richard Phelps, a partner in PricewaterhouseCoopers HR Services division. However, balancing cost savings against quality of service is crucial. “Although the current climate represents an opportunity for many organisations to use HR outsourcing to reduce cost the overall success of the deal requires continued focus on the quality of the service. Despite the tough market conditions, organisations need to clearly understand the importance of taking a holistic view of HR cost, capability and service.”

Outsourced payroll delivers the greatest cost savings for the very biggest organisations, says Phelps. Level of service measures, however, such as payslip error rates and % overpayments, do not report significant differences whether delivered in-­house or externally. “Overall though, our evidence suggests that driving both cost and service benefits from outsourcing is heavily reliant on a centralised and clear governance structure leading up to, during and after the transition,” he says.

When it comes to setting up an outsourcing arrangement, Jimmy Desai says organisations vary greatly in their approach. “Some will look to go through the process of setting up an outsourcing arrangement very quickly. Others are more risk averse and are prepared to really get involved in the contract, negotiating it, amending it. It really depends on the kind of culture the business has and its view of risk.”

Above all, he says, the key is to ensure that businesses select an outsourcing provider that is a good match for their organisation. “It sounds obvious, but when you drill down, outsourcing arrangements can be confusing. It is not all about headline price and size. You need to consider the detail of the contract: what kind of voice will the customer have; will the supplier react quickly to issues or will you be left hanging? It is possible to make some very expensive mistakes if you rush in without giving the details full consideration.”

First on the ‘buyer beware’ for businesses looking at outsourcing, says Desai, is price. Businesses need to understand what is included and when it will be reviewed. Canny buyers will look to cap annual reviews at a certain percentage to ensure that prices don’t escalate and will look carefully at the cost of any additional services. It is also prudent to think about what might happen in the future. If the customer merges with another company, for instance, its new size might put it in another pricing tier.

The next consideration is ensuring that service meets expectations and that those standards are maintained. The business’s expectations as to speed and accuracy need to be enshrined in service level agreements (SLAs) and penalties and perhaps even incentives set out.

“The point here is that an organisation needs to look at itself and what its specific requirements and needs are before going out into the market to select a supplier,” he says.

The customer supplier relationship also needs to be understood before the contract goes live. “With large suppliers it may be that if you are a small organisation (in terms of that supplier's customer base) you may get a smaller voice compared to that large supplier's bigger accounts. With a smaller supplier your organisation may be one of the larger accounts, in which case you may have more influence in terms of getting things done in the way that you would like,” he argues.

The end of the contract should not be overlooked. “Make sure that there are provisions to dictate what will happen on exit. Normally, these kind of contracts will have a transition to ensure a smooth handover either to you if you are taking it back in­-house or to a new supplier.

Finally, Desai points out, companies need to bear in mind that all of this due diligence and deal scrutiny comes at a price. A large contract may need input from lawyers, consultants and accountants to ensure it stacks up so negotiating the right price in the first place is key:

Conclusion

Caveats about balancing cost and service aside, commentators argues that outsourcing will undoubtedly be a key strategy for 2010.

“This year should be a game of two halves for outsourcing and there is likely to be increased sourcing across the board. After taking a battering through the recession, the private sector will look to outsourcing to re­staff with less risk. Outsourcing will become increasingly popular as companies re­build in what is a wholly changed business landscape. We also expect increased interest from the public sector as they work to streamline and reduce overheads,” says Martyn Hart.